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HSBC Summary: June 9 Strategy Day and Investment Outlook

Core Content

Goldman Sachs has reaffirmed its Buy rating on HSBC, highlighting the potential for a strategic shift towards Asia as a key catalyst for improved returns. The report outlines the need for management to implement a roadmap for incremental, selective pull-back from underperforming geographies outside of Asia, including Brazil, Turkey, the US, and Mexico. Additionally, the firm emphasizes the importance of further management actions to address ROE compressors, particularly through RWA reductions in the Global Banking and Markets (GBM) business and groupwide cost-saving initiatives. Lastly, the report considers the implications of potential re-domiciling and the UK retail ring-fenced bank (RBWM) on HSBC's financials and capital structure.

Main Points

• Strategic Shift to Asia: HSBC's Asian operations have a significantly higher ROE (mid-teens) compared to other regions (1%–3%), but only 40% of its capital is allocated to Asia, which has suppressed overall group returns to 7% in 2014.
• ROE Improvement Potential: By increasing capital allocation to Asia and reducing the capital burden in underperforming regions, the firm expects group ROE to improve from 7.4% in 2014 to 10.2% by 2017.
• Valuation and Target Price: HSBC is currently trading at 11X 2015E P/E and 1.0X 2015E P/B. The firm maintains a 12-month target price of HK$92.00, implying a 25% upside from the current price of HK$73.75.
• Investment Profile: HSBC is categorized under the Asia Pacific Buy List, with the firm believing the market is undervaluing its Asian franchise. Applying peer valuation multiples to its Asian business could result in a 22% uplift in group value.
• Catalysts for Growth: The report identifies potential improvements in operating profit and cost management as key drivers for the stock's performance, with a focus on reducing costs and improving margins.

Key Financials

Key Risks

• Minimal management actions
• Higher-than-expected capital requirements
• Weaker-than-expected top-line growth

Investment Profile Analysis

The Goldman Sachs Investment Profile suggests that HSBC's performance is below its peer group in terms of growth, returns, and multiple. However, the firm believes the potential for improvement in these areas is significant, especially with the strategic focus on Asia.

Valuation Scenarios

• Peer Valuation Approach: Applying peer P/E and P/B multiples to HSBC's Asian business could lead to a 22% uplift in group value.
• Capital Position: A potential sale of the UK ring-fenced bank stake could result in a one-off gain and improve the group's capital position, potentially reducing the GSIB capital charge from 2.5% to 2.0%.
• ROE and Capital: The bull case scenario highlights the potential for higher ROE and Core Tier 1 Capital (CAR), which could resolve the capital debate and support dividend progression.

Strategic Actions

• Capital Reallocation: HSBC should focus on increasing capital allocation to Asia to enhance returns.
• Cost Reductions: Implementing groupwide cost-saving efforts and RWA reductions in GBM is critical for improving ROE.
• Geographic Pull-back: Strategic exits from underperforming regions such as Brazil, Turkey, Mexico, and the US could improve returns.

Outlook

The report suggests that HSBC has the potential to significantly improve its financial performance through strategic restructuring and a focus on Asia. The firm believes that the current valuation does not fully reflect the value of the Asian franchise, and that a shift in capital allocation and management actions could lead to substantial upside for the stock.